Good news for Franchisors as Court Upholds Restrictive Covenants
Restrictive covenants are the franchisor's key safeguard against franchisees who think they can do better outside, and at a cost to, the network. However, a recent judgment reminds us that they can be challenged in Court. Unless drafted carefully and kept up to date with the developing law, there is a risk that a covenant might not offer the protection which was originally intended.
The franchisor in question, PSG Franchising Ltd ("PSG"), operated a business providing property searches for conveyancers and lenders. Lydia Darby Ltd (the "Franchisee") was a long-standing franchisee whose most recent written franchise agreement had expired in March 2011, although the parties continued to do business (apparently as before) until the relationship was formally ended in August 2012. PSG then discovered the Franchisee to have been operating a competing business since September 2011 or earlier. It applied for an injunction to stop the Franchisee from competing for a period, based on the restrictive covenant in its franchise agreement.
None of this is particularly unusual: most franchisors will find themselves in a similar position at some point. The outcome varies though, and depends greatly on the drafting of the agreement in question.
Here, the restrictive covenant sought to prevent the Franchisee, for a year, from providing competing services in its former franchise territory. There was also a restriction against soliciting former customers of the franchised business. For restrictive covenants to be reasonable (and thus enforceable) they must be limited geographically and by time in a way which is proportionate to the interest (such as its goodwill) that the franchisor wants to protect. While PSG's covenant was towards the more aggressive end of what is currently thought to be allowed, it did fall within those boundaries.
Nonetheless, the drafting left enough room for the Franchisee to argue in Court that the covenant was unreasonably broad and thus unenforceable. The Franchisee contended that the clause in fact stopped it competing anywhere in the UK where PSG operated, and providing services developed in future which had never been part of its own franchise. Happily for PSG, the Court ruled that interpreting the clause required the application of commercial common sense; the covenant meant what a reasonable person would have understood it to mean. That was not the same as what the Franchisee understood it to mean.
The Court also decided in PSG's favour the question of when the restrictive covenants should start and end. The Franchisee had argued that the covenants applied to it from the end of the last written franchise agreement, in March 2011, and so expired in March 2012. (Previous judges have expressed some support for this line of thinking, which illustrates the dangers of franchisors allowing franchisees to continue trading on when their agreement has expired.) Again, though, this Court agreed with PSG and decided that the covenants kicked in only after the franchise ended in practice, in August 2012.
This judgment is a reminder that the effectiveness of franchise agreements can vary with time and can be called into question by a franchisee. Even if a franchise agreement was prepared by specialist lawyers like our franchising team, it is a modest (but invaluable) exercise each year to confirm that the agreement remains in line with the developing law. Similarly, if a difficult termination is approaching, particularly where franchisor and/or franchisee haven't done exactly what the agreement originally intended, the early identification of possible problems will help you to nip them in the bud before they present a risk to your business.
For more information, please contact your usual franchise team member or: